Would a state income tax harm the economy? Far from proven.

A close look at the debate on the I-1098 proposal. Plus: Does Washington state really have a regressive tax system now?
Crosscut archive image.
A close look at the debate on the I-1098 proposal. Plus: Does Washington state really have a regressive tax system now?

Take heart. We're a backwater no longer. Washington may have missed out on the Civil War and the Revolution, but we're in the thick of history now. "The battle between taxpayers and government unions will define the fiscal future of the 50 states,'ꀝ says The Wall Street Journal ($), 'ꀜand the newest battlefield is Washington state. That'ꀙs where a few rich taxpayers led by Bill Gates, Sr. and the Service Employees International Union (SEIU) are bankrolling a November ballot measure to create the state'ꀙs first income tax.'ꀝ

As David Brewster noted on August 16, the Journal argues that Washington's I-1098 would stifle economic growth. The nine states without income taxes averaged job growth of 18.4% over the past decade, the paper observes, while the 9 states with the highest income tax rates averaged only 8.4%. Gates argues that only 3 percent of Washington households would pay the new tax. 'ꀜWhat he doesn'ꀙt say is that Washington'ꀙs lack of an income tax is among its main comparative advantages in luring those top 3%, along with their businesses and jobs, into the state. . . . Even liberal Democratic Governor Christine Gregoire begins her sales pitch to prospective business investors with the reminder: 'ꀘNo income tax.'ꀙ'ꀝ

Don't be fooled, the Journal's editors huff. 'ꀜIncome taxes are always sold as a one-time way to reduce deficits,'ꀝ they write, 'ꀜbut they always become engines of greater spending, and eventually deficits. Just ask Californians."

Actually, no one is selling I-1098 as a one-time way to reduce the state's looming budget deficit. Gates talks about fairness, about raising more money for public education and health care for low income citizens, about tax relief for the vast majority of small businesses. He might reasonably argue that the Washington legislature has proven itself very timid about raising taxes, very wary about stirring up another Tim Eyman initiative.

Dire predictions aside, what really is in the initiative, which will be voted on this November? And how many of the economic arguments against it hold up?

In a nutshell, 1098 would impose a 5 percent tax on individual income above $200,000 a year ($400,000 for a couple), and 9 percent on individual income above S500,000 ($1 million for a couple).

The Journal claimed that "Washington would move overnight from one of the nine states with no income tax to having the eighth highest rate in the country." Gates disputes that. He says that 'ꀜpeople who say our income tax is just like Oregon and California miss the reality. They need to look at 'effective' rate.'ꀝ Once a person crossed a threshold, the tax wouldn't be levied on income up to that level. The tax rates would apply only to income above the thresholds. For a couple with income of $1 million, Gates explained, 'ꀜthere would be a 5% rate against the amount of income over $400,000 or .05 x $600,000 or $30,000. In other places where the exemption is, say, $40,000, the tax is applied to $960,000 at a rate from 3% up to 9% for a total like $72,000 — a huge difference and an effective rate of 7.2%.'ꀝ

Sightline Institute disputes the now-infamous Wall Street Journal characterization, too. Sightline has posted graphs showing that a single person earning $350,000 would pay less income tax here than in any other state that taxes income. The Washington taxpayer would pay about $8,000, while the top state, Oregon, would extract $35,000, according to the chart.

The initiative would raise an estimated $1.7 billion a year. The first $700 million would be used to reduce state (not local) property taxes by 20 percent, and provide a $4,800 credit to payers of the business and occupation tax. This would result in a property tax reduction of about 4 percent (the state's share of property tax is only 20 percent) and would free 80 percent of the state's businesses from paying any B&O tax at all. The funds left over (an estimated $1 billion a year) would be divided 70-30 between education (both K-12 and colleges, but mostly public schools) and basic health.

So now, what about the arguments pro and con? Critics and defenders say look at who's backing (or opposing) the initiative. Naturally, given a tax matter, there's a lot of naked self-interest involved. Further, opponents of I-1098 say look at the legislature's track record — you can't trust those guys.

Let's stipulate that you can't trust the legislature and that there is a lot of naked self interest among the backers on both sides. (I'll deal with those arguments in a later piece.) But whatever the legislature may or may not do, and whatever some backers and foes of the initiative may or may not stand to gain, let's try to look dispassionately at these questions: If I-1098 works as intended, will it right real wrongs? Will it be good for business or bad?

Both sides in the debate think that if voters understood I-1098 better, those voters would agree with them. And both sides realize that an initiative campaign relies more on the visceral than on the intellectual. As Mark Funk, who is handling media relations for I-1098 opponents, says, it usually boils down to 'ꀜfour sound bites on each side.'ꀝ

No one denies that the initiative would take 80 percent of the state's businesses off the hook for B&O tax. It would presumably remove one of the many barriers facing a person who wants to start something really small. The question is whether or not the net impact would be positive or negative for statewide economic growth and jobs.

Many small and not-so-small businesses operate as partnerships, limited liability companies, or S corporations, none of which pay federal corporate income tax. The money they earn passes through to the individual owners. I-1098 opponents argue that if you tax business owners on their high personal incomes, you're really taxing their businesses — because you're dealing with the same dollars.

Initiative foes Joe Barer, president of the strategic consulting firm Lake Partners, and Matt McIlwain, a managing director of the Madrona Venture Group, argue that marginal costs drive business decisions, and a new tax will make some business owners think twice about investing or hiring. The tax would also discourage people from moving or staying here to start the next big thing.

At either the state or national level, most of the very few people who would pay a tax on high personal income arguably aren't those who would be building companies or creating jobs.

'ꀜThe proposed income tax would penalize small business owners and entrepreneurs . . . and damage our state'ꀙs national and global competitiveness for new investment and job creation,'ꀝ a Washington Research Council >Policy Brief argues. 'ꀜBecause S corporations, LLCs and partnerships . . . have their income passed through to owners'ꀙ (shareholders'ꀙ) individual tax returns, I-1098 imposes a substantial new business tax on many of this state'ꀙs small, emerging, and dynamic enterprises. This is certain to discourage entrepreneurial activity in the state.'ꀝ

The opponents' strategy has been to rally to the defense of small business, deflecting attention from their solicitude for the very wealthy. But what about the rich? Here, the local argument echoes debates over letting the Bush tax cuts for top-end earners expire. At either the state or national level, most of the very few people who would pay a tax on high personal income arguably aren't those who would be building companies or creating jobs.

In an article about the impact of losing the Bush tax cuts, Jackie Calmes reported in The New York Times that 'ꀜRepublicans do not emphasize the impact of extending the tax cuts for wealthy individuals. Rather, they say Mr. Obama is about to spring a big tax increase on many small-business owners who file their taxes as individuals. Analyses from the Joint Committee on Taxation and the Tax Policy Center, a nonpartisan research organization, show that less than 3 percent of filers with small-business income pay at the top two income tax rates, and many of those are doctors and lawyers in partnerships.'ꀝ

Reagonomic theology aside, evidence doesn't show that at a national level, higher taxes mean lower growth. Paul Krugman wrote in July that 'ꀜin a rational world, the failure of the economy to do anything special after those [Bush] tax cuts, following a boom period after the Clinton tax hike, would have cast strong doubt on any claims about the favorable impacts of tax cuts on the economy."

On a state level, an income tax by itself doesn't drive away entrepreneurs or investors. And it doesn't keep a state out of the red. Just look at California. The Golden State has both personal and corporate income taxes. It also has Silicon Valley.

1098 opponents say that's just the point. It's true that California has plenty of industry and venture capital, McIlwain acknowledges, but 'ꀜthey have Silicon Valley." The complex of high-tech companies, venture capitalists, and first-rate university research has created a magnet for investors and entrepreneurs. We're trying to build something similar here, but we don't have it yet. In the meantime, lack of a personal income tax is one of our relatively few selling points. Besides, McIlwain says, 'ꀜtalent and capital are flowing out'ꀝ of states such as California and New Jersey.

Whether or not one is driving off the geese that lay the golden eggs, is it fair to sock a single, rather small group of taxpayers with the full burden of a new tax? 'ꀜTen states — Washington, Florida, Tennessee, South Dakota, Texas, Illinois, Michigan, Pennsylvania, Nevada, and Alabama — are particularly regressive," according to the ITEP study.

One can also ask (at least at the federal level) whether or not more of the burden should be borne by an even smaller group, and whether or not any American tax system distinguishes adequately between the filthy rich and the merely well off. 'ꀜThe fight on Capitol Hill over whether to extend the Bush tax cuts is about many things,'ꀝ James Surowiecki wrote in The New Yorker: 'ꀜdeficit reduction, economic stimulus, supply-side ideology. But at its core is a simple question: who counts as rich?'ꀝ Surowiecki argues that the tax code didn't capture the large and growing gap between the people at the absolute apex of the economic pyramid and everyone else. Recall that between 2002 and 2007, the top 1 percent's share of national income doubled, to 23 percent of the whole, while the top 0.1 percent's share tripled. As a result removing the Bush tax cuts burdens the super-rich no more than it burdens moderately successful professionals. As Surowiecki puts it, 'ꀜsomeone making $200,000 a year and someone making $200 million a year pay at similar tax rates. LeBron James and LeBron James'ꀙs dentist: same difference.'ꀝ

Gates says he has some sympathy for the argument against loading a new financial burden exclusively on to a fairly small group of people. But under our current tax system, he says, the alternative is loading it onto another identifiable group, the poor — which he says would be 'ꀜterrible.'ꀝ

Up pops another debate: Does Washington's current tax system really stick it to the poor? The Washington, D.C.-based Institute for Taxation and Economic Policy, says Washington has one of the 'ꀜ'terrible ten' most regressive tax systems.'ꀝ The ITEP explained in a press release last November that 'ꀜby an overwhelming margin, most states tax their middle- and low-income families far more heavily than the wealthy.'ꀝ However, it said, 'ꀜten states — Washington, Florida, Tennessee, South Dakota, Texas, Illinois, Michigan, Pennsylvania, Nevada, and Alabama — are particularly regressive. These 'ꀜTerrible Ten'ꀝ states ask poor families (those in the bottom 20 percent of the income scale) to pay almost six times as much of their earnings in taxes as do the wealthy. Middle-income families in these states pay up to three-and-a-half times as high a share of their income as the wealthiest families.'ꀝ

Gates and other 1098 supporters frequently cite the ITEP findings. Opponents suggest that its flawed analytical methods produced flawed results.

'ꀜThe popular conception that Washington'ꀙs tax system is the most regressive in the nation is based on a study with serious flaws that bias the comparison to other states,'ꀝ the Washington Research Council says. 'ꀜThe system is certainly less regressive than the study makes it appear.'ꀝ Basically, the Research Council says. 'ꀜITEP — the research arm of Citizens for Tax Justice, a labor-backed advocacy group — fails to accurately measure the tax burden. 'ꀝ

McIlwain and Barer both argue that Washington's tax system looks pretty progressive if you count everything. Barer explains that measuring the impact of Washington's system turns on three key assumptions:

1) For high earners, the question is whether you treat the B&O tax as a corporate income tax or a sales tax. A sales tax is passed on to consumers. An income tax is paid by the owners. The ITEP treated the B&O as a sales tax, Barer argues, while it should be treated as a corporate income tax — which means the business owner with a high income is paying plenty.

2) When the ITEP considered impact on the middle class, it excluded the middle-class elderly. The elderly can get exemptions; for instance, many pay less in property tax. Include the elderly, and the middle class doesn't suffer under Washington's system.

3) In calculating the tax impact on people at the bottom, the ITEP didn't include cash payments government makes to the poor. Barer argues that you should subtract what government gives the poor from what government takes away. If you do that, the poor are not bearing a heavy burden.

'ꀜYou'd have trouble finding a lot of people who didn't view'ꀝ the B&O tax primarily as something passed along to consumers, replies Matt Gardner, main author of the ITEP study, 'ꀜYou don't get a lot of quibble from economists on the idea that the B&O tax is primarily a tax on consumption.'ꀝ However, he concedes, 'ꀜthere's a kernel of truth in the view that it's also a tax on capital income,'ꀝ because 'ꀜthere's only so much you can push forward to consumers.'ꀝ In fact, he says, part is shifted to owners, and part is shifted to workers in the form of lower wages. It's all 'ꀜa question of degree.'ꀝ Still, Gardner says, 'ꀜmy question right back would be: What fraction of it they say isn't'ꀝ a consumption tax?

Looking at the middle class, it's 'ꀜunambiguously true,'ꀝ Gardner says, that 'ꀜproperty tax breaks that are available to seniors are more generous'ꀝ than those available to anyone else. But the breaks are offered by state and county governments, and they vary widely from place to place. How can you reasonably calculate them? And does it matter? On one hand, Gardner says, seniors do get the tax breaks. On the other, since many of them have homes that have appreciated in value and many have incomes that have declined, they probably pay higher percentages of their income in property tax than any other group. The Minnesota Department of Revenue performs a similar analysis without excluding seniors, he says, and 'ꀜjust looking at it informally, I don't see any difference.'ꀝ

Gardner says the argument that the poor don't pay much if you subtract all the benefits they receive is familiar — and flawed. 'ꀜThe most obvious difference'ꀝ between what the poor get from government and what everyone else gets is that poor people receive 'ꀜcertain types of benefits that are really easy to quantify.'ꀝ But government also gives better-off citizens schools and police protection, urban amenities and roads 'ꀜWhy are you focusing just on the one?'ꀝ Gardner asks. 'ꀜThe answer is, it's easy to calculate. But that's not a good answer.'ꀝ

Opponents say 1098 is the wrong tax at the right time. But they don't say what the right tax would be. Ask what the right tax would be, and you're not likely to get an answer. This isn't a campaign for anything, Funk explains. It's a campaign against Initiative 1098. McIlwain notes that a bi-partisan coalition has come together to fight 1098, and he suggests that it could ultimately come up with a better idea. But not yet.

In the meantime, Gates has found an idea he likes just fine. 'ꀜThis is the right tax at the right time,'ꀝ he laughs.


Please support independent local news for all.

We rely on donations from readers like you to sustain Crosscut's in-depth reporting on issues critical to the PNW.


About the Authors & Contributors

Daniel Jack Chasan

Daniel Jack Chasan

Daniel Jack Chasan is an author, attorney, and writer of many articles about Northwest environmental issues.